Whether you are a startup business or a well-established business, there are two main types of financing to consider: debt and equity. As a business owner, it is worthwhile to understand the pros and cons of each while considering the best option for your business.
Debt financing is a way to fund your business by borrowing money. A lender typically gives you a loan and then you pay it back over time with interest. This lender could be a financial institution or even a family member or friend. To qualify for debt financing, many institutions require a company to show some operating history and profitability. Lenders typically require collateral, a business plan, good credit scores, copies of your tax returns, financial statements, and an application. Before obtaining financing, make sure your business can service the debt with current cash flow.
- Allows you to retain ownership and have control over how the capital is spent
- Is easier and faster to obtain and can be used by almost any type of business
- Interest paid on the loan can be deducted on the business’ tax return
- Enables the business owner to recognize a return on investment rather than equity investors
- Comes in a variety of options with wide ranges of how much money you can obtain and how long you will make repayments
- Becomes an obligation to repay the amount borrowed plus interest each month
- Requires a monthly payment despite whether or not you make money
- Failure to pay (defaulting) could lead to loss of collateral or personal assets
- Can be difficult to obtain with a low credit score and weak financial performance of the business
Equity financing is a way to raise funds by selling ownership in your company. In exchange for capital from investors, you give them a portion of ownership and control in your business. Investors may be angel investors, venture capitalists or even a family member or friend. Prior to an investment, investors generally request a business plan. Within this business plan, investors look for a strong management team, a demonstrated need for the product or service, and a clearly-defined pricing and sales strategy.
- An investor provides experience, wisdom, connections, and mentorship
- Easy to secure this type of funding online
- Great for technology startups and high growth companies
- Helpful for new businesses with no revenue or little profit
- High-risk can result in high returns
- An investor receives ownership and influence in the company
- Investors expect a healthy return on investment
- Obtaining equity can be a long and gruesome process
- Investors will require financial reporting to track their investment
Figuring out how to finance your business can be a big decision with far-reaching consequences. As such, pursue debt or equity financing with the goals of your business in mind. To learn more about the various types of debt and equity funding check out Funding Your Dream Business.